“It looks like we may have the outlines of a deal around the financing!” Steve Shafran, a senior adviser at Treasury, announced to Bart McDade and the Lehman team at the NY Fed. Brandishing a huge smile, Shafran told the Lehman bankers that the CEOs downstairs were close to agreeing to funding the spin-off of Lehman’s real estate assets.
The men felt as if an unimaginable burden had been lifted almost instantaneously from them. And McDade excitedly tapped out a message on his BlackBerry to Michael Gelband, who was at Simpson Thacher’s offices.
Standing in a conference room uptown, Gelband read McDade’s message and shouted, “We got it!” he said, a broad grin spreading across his face as he let out a sigh of relief.
Hector Sants, the deputy head of Britain’s Financial Services Authority, was driving along the A30 from Cornwall on the southwestern tip of England back to London on Sunday afternoon with his cell phone clutched precariously between his ear and his shoulder.
Sants had been on the phone for most of the weekend with his boss, Sir Callum McCarthy, head of the FSA and a former Barclays banker himself. McCarthy, at sixty-four years old, had only six days remaining in his tenure in the post and was scheduled to step down that Friday.
Sants and McCarthy had spent hours trying to assess the state of affairs between Barclays and Lehman. Sants had been in contact several times with Varley that day, but McCarthy’s efforts to contact Geithner, his counterpart in the United States, were proving more difficult. They had spoken briefly on Saturday, but he had heard nothing since.
“He hasn’t called me back,” McCarthy grumbled. “You can’t get hold of any of these people.”
They had no idea what Barclays’ Diamond had—or had not—communicated to the U.S. government about what conditions had to be met to receive their blessing back in Britain. Indeed, McCarthy was nervous that Diamond, an American who had never become part of Britain’s gentlemen’s club, may have been a bit reckless in the negotiations, like any aggressive Wall Streeter. Both men were especially concerned that Diamond, in his zeal to sign a deal, might not have fully explained the requirements that the British regulators would ask for before approving it. To them, buying Lehman could put the bank and the British financial system as a whole in jeopardy. Varley, who was supportive of pursuing Lehman but clearly less enthusiastic than Diamond, had assured Sants during a call on Friday that Barclays’ board would only pursue the deal if it could receive adequate help from the U.S. government or another source. “I would not recommend a transaction to my board unless I’m satisfied both in terms of the quality of the assets we’re purchasing and in respect to the funding positions,” Varley had said.
McCarthy and Sants also faced another looming problem, one that, in the grand scheme of things, may have seemed minor but was nonetheless important at that very moment: The London Clearing House (LCH, Clear-net), which clears many of the derivative counterparty trades across Europe, was scheduled to migrate its entire energy futures business—worth over 100 billion pounds—to a completely new computer system that weekend. They had instructed the London Clearing House on Saturday to hold off on proceeding with the upgrade until they knew more about the fate of Lehman and Barclays, but were now being badgered for a final answer, as dozens of technicians had been engaged to handle the switch-over.
“We shouldn’t allow this to drag on,” Sants said to McCarthy, hoping they could get an answer back to the London Clearing House. “We ought to try to contact Geithner and just make our position very clear.”
They scripted out what McCarthy would say: “We feel as the regulator [sic], in the best interest of the global financial system, that it’s important you understand—we hope Barclays has already made this clear to you, but in the event Barclays has not made this clear to you—that we need the appropriate funding assurances both on the trading side and with regards to the asset issues if we’re going to allow this to go forward.”
McCarthy said he would try Geithner one last time.
On the thirteenth floor of the NY Fed, Hilda Williams, Geithner’s assistant, told him that Callum McCarthy was on the phone. Geithner finally took the call, explaining, brusque as ever, that he had been in back-to-back meetings trying to get a deal together for Lehman and apologizing for not returning his call sooner.
McCarthy stopped him, saying that he was very concerned that he didn’t know anything about the deal being contemplated. He had a list of questions that he needed answered.
“The capital requirements and, in particular, the transaction risk between the time of taking on the risk and the completion of the transaction leaves a very big open-ended exposure,” McCarthy said, keying in on his biggest problems with the deal. He explained that the FSA still needed to determine whether Barclays was properly capitalized enough to take on the risk of buying Lehman. And, he said, even if it was—which he suggested was a possibility—Barclays still would need to find a way to guarantee Lehman’s trades until the deal was completed. “I’m very doubtful Barclays can ever get to a position to fulfill the requirements, and it is far from clear that they will be able to do so,” he said.
Geithner had no idea that the FSA would take such an aggressive position and asked McCarthy directly whether the authority was formally saying it wouldn’t approve the deal.
“It is completely impossible for us to take a view on whether these risks are risks that we would accept,” McCarthy replied, unless “you bring a proposal forward.” But, he added, since it was so late in the day—about 3:30 p.m. in London—the chances were remote they’d be able to come to a conclusion within the next several hours.
McCarthy went on to present another problem: He said that Barclays could not guarantee Lehman’s trading obligations without a shareholder vote, which was a UK “listing requirement” for all publicly traded firms in Britain. However, not only was there insufficient time for such a vote, but he said that he wasn’t authorized to waive the vote requirement—only the government could do that.
Geithner explained that, based on his conversations with Barclays, he thought the British government had already indicated it would be supportive of the transaction.
“I have no indication that that is the case at all,” McCarthy said firmly, and then expressed anxiety, as Darling had to Paulson on Friday, about Barclays’ own health and that of the rest of the market.
“Look,” Geithner said impatiently, “we’re going to have to decide in the next half hour what we do. Time is running out.”
“Good luck,” McCarthy said curtly.
Geithner ended the call and rushed into Paulson’s office, where the secretary and Chris Cox were speaking, and recounted the conversation.
“I asked him if he was saying no,” Geithner said, “and he kept saying that he wasn’t saying no.” But clearly, Geithner complained, that’s exactly what he was saying.
Paulson was beside himself. “I can’t believe this is happening now.”
After a brief discussion of strategy, Paulson ordered Cox, who was the only regulator in the room with legal authority over Lehman Brothers, to call McCarthy. Cox, Paulson thought to himself with a sense of annoyance, was supposed to have prewired these very regulatory issues. “I don’t want to be left here holding Herman,” the Treasury secretary said, glancing at his zipper in case the joke wasn’t clear.
Cox reached McCarthy on his cell phone in the living room of his two-story home in Blackheath, across the Thames River. After the FSA head patiently reiterated the problems that the Barclays deal faced, Cox suggested they could try to work around them, adding, “You seem to be very unsympathetic to this.”